Oil-price manipulation: the next Libor?

Regulators have warned that benchmarks for the oil market could be manipulated in a similar way to interbank rates.

Some of the world's biggest oil companies may have a new mess on their hands.

The European Commission raided the offices of Shell, BP and Norway's Statoil this week as part of an investigation into suspected attempts to manipulate global oil prices spanning more than a decade.

None of the companies have been accused of wrongdoing, but the controversyhas brought back memories of theLibor rate-rigging scandal that rocked the financial world last year.

UBS(UBS), Royal Bank of Scotland(RBS) and Barclays(BCS) have already reached settlements with regulators in the U.S. and U.K. over Libor-rigging, paying over $2.5 billion in fines after admitting to attempts to manipulate interest rates to appear more credit-worthy and to benefit trading positions. Roughly a dozen other global banks remain under scrutiny over rate-rigging, and three people have been arrested so far.

A review ordered by the British government last year in the wake of the Libor revelations cited "clear" parallels between the work of the oil-price-reporting agencies and Libor.

"[T]hey are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities," the review, led by former financial regulator Martin Wheatley, said in August . "To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion."

Libor -- short for the London Interbank Offered Rate -- is a collection of rates designed to measure the cost of borrowing between banks. The quotes are then used as benchmarks for roughly $10 trillion in loans and some $350 trillion in derivatives.

In the setting of Libor rates, groups of banks are asked what interest rate they would have to pay to borrow money for a certain period of time in a certain currency, with averages calculated after several of the highest and lowest submissions are removed.

Libor-setting is overseen by the British Bankers Association, an industry trade group, though U.K. law was changed last month to allow financial regulators to supervise the process.

Oil-price benchmarks are set by independent "price-reporting agencies," the most influential of which is Platts, a division of McGraw-Hill(MHFI). Platts' data is used help set prices for billions of dollars' worth of physical oil and derivatives contracts.

As the Libor scandal gathered force last year, Platts and its fellow price-reporting agencies, Argus and ICIS, issued a joint statement emphasizing what they called the "fundamental differences" between their "reliable and robust" methods and those used in calculating Libor. Some observers, however, say the processes are similarly vulnerable.

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Platts collects voluntarily submitted information on bids, offers and transactions in the otherwise opaquephysical-oil market in an effort to provide an assessment of the market price around the close of trading. The process is complex, and while traders can't predict it perfectly, they recognize that transactions late in the day are most important, said Rosa Abrantes-Metz, a principal at Global Economics Group who has studied Platts.

"If you put in a price that is a bit off, you can affect the benchmark in a meaningful way, particularly because there just aren't that many transactions at the end of the day," she said. "You may try and move Platts in a particular way and lose in that transaction, but then gain, by moving the index, in a larger transaction on the opposite side or on your derivatives position."

There are also concerns about the fact that reporting to Platts is done by traders voluntarily. In a report issued in October, the International Organization of Securities Commissions -- an association of regulators -- said the ability "to selectively report data on a voluntary basis creates an opportunity for manipulating the commodity market data" submitted to Platts and its competitors.

Responding to questions from IOSCO last year, French oil giant Total said the price-reporting agencies, or PRAs, sometimes "do not assure an accurate representation of the market and consequently deform the real price levels paid at every level of the price chain, including by the consumer." But Total called Platts and its competitors "generally... conscientious and professional."

"While there is the risk of market actors voluntarily submitting false data to the PRA assessment process, most PRAs have effective processes to verify submissions and generally avoid this problem," Total said.

Platts describes its methods as "structured" and "highly transparent," saying the submissions it collects must reflect verifiable transactions or executable bids and offers. The agency vets submitters and restricts them from altering their bids and offers beyond defined increments to mitigate against sudden price swings.

Platts declined to comment in detail on the European Commission investigation, saying only that investigators visited its office in London on Tuesday and that it is "cooperating fully" with the probe.

U.S. Sen. Ron Wyden wrote to Attorney General Eric Holder on Friday asking that the Justice Department join the investigation, though it's not clear whether American regulators will get involved. Spokesmen for the Department of Justice and the Commodity Futures Trading Commission declined to comment.

Shell(RDSA), BP(BP) and Statoil(STO) all confirmed that they were cooperating with the European Commission. Italy's Eni(E) said it had not been visited by officials but had received a request for information and would be cooperating.

Aside from the big oil companies, Wall Street banks are also big players in the energy markets who could conceivably benefit from price movements, said David Frenk, director of research at the financial reform group Better Markets and a former commodities analyst at a hedge fund. If Platts' data was indeed manipulated, Frenk said, consumers as well as other traders took a hit.

If the benchmark was manipulated upward, that would mean higher oil prices and more expensive gasoline, Frenk said. If it was manipulated both up and down at various times, that volatility would increase the cost of hedging for gasoline resellers, who would in turn pass that cost onto drivers.

"Even small distortions of assessed prices may have a huge impact on the prices of crude oil, refined oil products and biofuels purchases and sales, potentially harming final consumers," the European Commission said this week.